COST ALLOCATIONS FOR HOSPITAL MANAGEMENT

Journal of the International Academy for Case Studies, 2008 by Marquis, Linda M, Ruh, Lorraine

CASE DESCRIPTION

The primary subject matter of this case concerns structuring cost accounting information. A secondary issue is the focus on how the information might be used and to this end there are no numbers in the case. Depending upon the requirements chosen by the instructor, this case could be successfully used in an undergraduate cost accounting or accounting information systems course. It could also be an effective tool for an MBA-level managerial course. Level of difficulty would therefore be at the four or five level. The case is designed to be discussed in one and one-half hours and should take students no more than five hours of outside preparation.

CASE SYNOPSIS

This hospital-based cost accounting case is unique in its lack of numerical information. The objective is to make students focus on the way the information should be structured and the way the information may be used rather than completing some financial reports. For most students this is far more challenging than it appears at first Jamesville Hospital has grown rapidly, but its accounting system is still very basic. The financial records are adequate, but the hospital's growth has challenged the management team to provide improved information about revenue and cost centers in preparation for developing information about the costs of the various procedures. The real issue in this case is that as the hospital grew, its accounting system did not evolve in a useful, practical or logical manner. Few departmental managers actually use the data generated by the current accounting system so the hospital has no real way to manage its costs.

HISTORY

James ville Hospital (JH) opened its doors in 1861 as a church supported hospital and orphanage. The oldest building still in use by JH was occupied in the early 1900's. Over the years the city of Jamesville grew out and around the hospital site; consequently needed expansions were constrained by the physical location. Eventually in the late 1970' s, the hospital opened a second site in the suburbs; the administrators had sufficient foresight to buy enough land to allow for major expansions after the initial building was occupied and growth continues at this location up to the present day. In the early 1990's JH branched farther out into the region with the purchase of a hospital 40 miles away. Currently the Jamestown Hospital has three fully utilized hospital sites as well as several satellite operations that support its healthcare mission. The satellite operations are not considered financially material to the hospital's operation. They are viewed as an outreach to the community of doctors and patients at a cost that the hospital management deems immaterial.

STRUCTURE

Organizationally, JH is composed of over 120 units - some are viewed as cost centers, while most (over 80) are revenue centers. Most departments are considered to be a single revenue or cost center, but some departments contain two or more revenue centers. (Examples of cost and revenue centers are listed in Table 1.) Because of the centralized administrative decision-making structure, no units are considered investment centers. Most of the units are managed by medically trained personnel (e.g., nurses, pharmacists, technicians, nutritionists, etc.) with no background in accounting or management; thus the financial management decisions are made by central administration.

ACCOUNTING SYSTEMS

About 3 years ago, JH implemented the Costex cost accounting system. This purchased software is not a part of the financial accounting system, but downloads the general ledger information and recasts that data into expense reports for each cost or revenue center. These reports are distributed to the management team for each cost or revenue center. Although the Costex system is capable of quite sophisticated processes, the management team uses little of the system's capabilities due to a lack of managerial accounting expertise.

The original implementation of the Costex system was limited. The financial accountants, with the unsophisticated assistance of the managers of the revenue and cost centers, completed an initial cost allocation model which has never been updated or reviewed. With no experience or education in management or accounting, only a few of the managers understood the need for accurate cost information - most considered it useless, at best, and punitive, at worst. Generally the managers of the cost and revenue centers do not use any financial reports and have difficulty providing supporting information (such as the amount of medical supplies needed for a procedure or the length of that procedure or the number and type of staff needed) that is accurate, reasonable or timely. see Exhibit A for an example of a typical cost report for a revenue center. The only part of the report that managers of cost or revenue centers described as understandable is the total cost line.

Data downloaded from the general ledger and entered into Costex is classified in one of three ways: